## Friday, March 31, 2017

### Competition issues in India's online economy

Smriti Parsheera, Ajay Shah and Avirup Bose.

The world of high technology companies is seen as a dynamic area with a rapid pace of creative destruction. There is, however, a class of industries where there are strong network effects, where the market tends to collapse into a narrow set of players. After one burst of innovation where a new online business is born, there is the possibility of entrenched market power with the extraction of consumer surplus.

Many firms, global and Indian, have resorted to the strategy of making large losses by subsidising users, as a way to obtain those network effects. This has created a new class of concerns about predatory pricing, with unprecedented negative profit margins on a sustained basis, being supported by equity capital infusions. In the short run, discounts are popular, but recoupment is inevitable and market power will adversely affect consumers in the future.

In a recent Paper, we argue that the existing competition law regime in India needs to be fine tuned, for technology-enabled markets with significant network effects, to address the possibility of new kinds of abusive conduct. We offer a series of tangible proposals through which the Competition Commission of India can better handle these emerging situations. We also look into the role and responsibilities of the investors who back these online businesses and the impact of their conduct on competition in the underlying markets.

### Entry barriers in the new economy

Innovation is the foundation of economic progress. While we normally revere technology companies for their disruptive innovations and the efficiencies that they create, we must recognise that some technology-driven businesses are susceptible to the acquisition and abuse of market power. The Indian competition regime is an evolving one, and has only recently started facing some of these concerns. Our paper brings new evidence and arguments to the table, on these questions.

Internet-based businesses, along with several other high-technology sectors, form part of the 'new economy', characterised by high rates of innovation; low marginal cost; increasing returns of scale; and, in many cases, network effects. Direct `network effects' arise where a user's benefit from a product or service increases with the number of other users on that network. The benefit of being on Facebook or WhatsApp, for instance, corresponds with the number of friends and family who use that service. Contrast this with the benefit of having an email address, where the benefits are not limited to closed proprietary networks. This became possible due to the early adoption of interoperability standards in email protocols.

Network effects are particularly important in two-sided markets where users on each side of the market derive a positive effect from the expansion of users on the other side. Commuters who use taxi aggregation platforms like Ola and Uber will logically be attracted to a service that has a large number of drivers on its network, which yields a lower waiting time. The same is true for the drivers working with these platforms. Similarly, in case of payments wallets, in the absence of interoperability regulation, merchants and customers will both prefer a service that has the most addressable users.

With the use of modern technology, the cost of running the marketplace itself has dropped to near zero levels. As an example, the online classifieds site Craigslist reports that it has about 40 employees who manage a network that sees over 80 million classified ads per month. The marginal cost of a transaction has gone to near-zero levels. This gives a unique class of problems where technological innovation that yields cost reductions cannot be a mechanism to take on an incumbent.

### Brain versus brawn

How can market power be established, in this new world? One mechanism through which one player can obtain a competitive advantage is to attract users through technological innovation, and thus get a network effect started. This is an attractive strategy for firms which have deep human capital. Another mechanism is by using financial capital to pay subsidies that entice users. This is an attractive strategy for firms which have superior access to financial capital. Many online businesses have resorted to practices like deep discounting, cash-back offers and other schemes designed to attract new users and establish the network effect. Sometimes, heavy losses have been sustained for years on end.